Many people have business ideas, but don’t know how to validate them and when to start scaling the business.
That’s why we developed a simple to follow framework that shows you how you can get from an idea to scaling your business in an efficient manner.
Generate as many business ideas as possible using the bottom-up or top-down approach. Once you are done, then select the 2-4 most promising ideas for entering the next step.
2. Model logic & assumptions
For each of your promosing ideas you need to build a rough business model logic (don’t worry, I’ll come to that in a minute :-)) with the associated assumptions and define a hypothesis for scaling your business.
A) BUSINESS MODEL LOGIC
The business model logic describes the rationale how you will create, deliver and capture the customer value. The business model canvas shows the main components to consider.
The main questions you need to answer related to your business model are the following:
- Customer segments; What different customer segments are we targeting and which customer segments generate most sales and profit?
- Customer relationships; How does each of our customer segments expect us to establish and maintain our customer relationship and how are we currently doing it?
- Channels; Which channels do we need to use in order to reach different customer segments in order to acquire customers cost efficiently?
- Value proposition; What bundles of products and service are we offering different customer segments and which customer problems do we actually solve?
- Revenue streams; For what value are our customers willing to pay? How do customers want to pay? What are our largest revenue streams?
- Key partners; Who are our key partners and key suppliers? Which key activities do they perform and which key resource are we acquiring from them?
- Key activities; What key activities do our value proposition require for example in the distribution channels, customer relationships and revenue streams?
- Key resources; What key resources do our value proposition require for example in our distribution channels, customer relationships and revenue streams?
- Cost structure; What are the mayor cost drivers (resources, activities) inherent in our business model?
B) KEY ASSUMPTIONS
After you’ve answered all questions you will have a good grasp of what drives your business model. Now, you need to define a list of key assumptions that make or break your business model. Limit yourself to 6 key assumptions. The following examples underline what I mean.
- Example #1: ECOMMERCE – customer acquisition costs, order economics (basket size, gross margin, return rate), repurchase frequency
- Example #2: SaaS – customer acquisition costs, monthly average revenue per user, customer lifetime (=1/monthly churn rate)
C) HYPOTHESIS FOR SCALING
After you’ve identified the key assumptions, you need to state under what circumstances you would start scaling your business. For example, you could state the following hypothesis:
“IF I can acquire 10 customers for a maximum of $40 each and I earn a gross profit of $60 per customer while less than 10% of the customers return the order, THEN I will start scaling my business (because I know, I can make tons of profit :-)).
This hypothesis needs to be crisp, so you know when your hypothesis has been falsified!
3. Validate assumptions
You want to validate your key assumptions and the related hypothesis cheap, fast and reliable. Reliable means that your test results should be a good indicator for the future.
A proven way to test your hypothesis is by building a minimum viable product (short: MVP). A MVP is used for fast and quantitative market testing of product features and encompasses the core features of your product only.
The MVP of a website selling a product or subscription based service could be as follows.
- Build a simple landing page; show your product offering and be able to convert visitors to customers (Tip: Use free tools for that; this is only for testing and learning purposes)
- Create a search engine marketing campaign (e.g. google adwords); select relevant key words, spent $500-$1,000 on campaigns and learn about your customer acquisition costs.
- Execute A/B tests in order to optimize your MVP; e.g. change the structure of your landing page and see what is the difference in the behaviour of your visitors.
After you have sufficient test data, you should be able to validate or falsify your hypothesis and then state what to do next.
WHAT TO DO NEXT
(A) GO BACK TO IDEA MODE, if your test results are significantly worse than assumed.
(B) START SCALING YOUR BUSINESS, if your test confirmed your assumptions.
(C) GIVE UP, if you … NO… You won’t give up. You go back to the idea mode and look for a new and better idea!
4. Scaling your business
Once you’ve identified your product market fit (= your hypothesis is validated and you have the justified belief to earn some money when scaling) you should scale your business.
MISTAKES YOU BETTER LEAVE FOR OTHERS
1. FORGET ABOUT BUSINESS MODELLING
Many founders forget to really understand which factors are driving their business model. Maybe they are too focused on one part of the business model and thereby neglecting the holistic business model. Or they don’t know how to create a basic business model canvas. You don’t need to become a modelling expert and building extensive financial models, but you should at least be able to create a business model canvas.
2. DON’T KNOW WHAT AND HOW TO TEST
Again, focus on the main drivers and be rigorous in defining methods for testing your assumptions. If you are not rigorous enough, you will miss a great opportunity to learn and improve your minimum viable product.
3. SCALING TOO EARLY
If you are scaling your business while your product market fit or your core processes are not established, then you are loosing money for no reason. Studies have shown that finding a product market fit takes 2-3 times longer than founders expect. I can confirm this based on my own entrepreneurial experience.